BUSFIN 3120 FINAL

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When the bond price is less than the face value, the bond trades. . .

"below par" or "at a discount" which occurs when coupon rate < yield to maturity

When the bond price is greater than the face value, the bond trades. . .

"above par" or "at a premium" which occurs when coupon rate > yield to maturity

When the bond price is equal to the face value, the bond trades. . .

"at par" which occurs when the coupon rate = yield to maturity

MACRS Year 0 Year 1 Year 2 Year 3 Depreciation Rate 33.33% 44.45% 14.81% 7.41% A firm is considering the purchase of a new machine for $325,000 . The firm is unsure if it should use the 3-Year MACRS schedule or straight-line depreciation over three years. What is the difference in the book value after three years if the firm uses MACRS instead of straight-line depreciation?

$0 (At the end of three years, both will be completely depreciated, thus $0 - $0 = 0)

Quisco Systems has 6.5 billion shares outstanding and a share price of $ 18.09. Quisco is considering developing a new networking product in house at a cost of $ 536 million. Alternatively, Quisco can acquire a firm that already has the technology for $ 887 million worth (at the current price) of Quisco stock. Suppose that absent the expense of the new technology, Quisco will have EPS of $ 0.66. Suppose Quisco develops the product in house. What impact would the development cost have on Quisco's EPS? Assume all costs are incurred this year and are treated as an R&D expense, Quisco's tax rate is 35 %, and the number of shares outstanding is unchanged.

$0.61

Quisco Systems has 6.5 billion shares outstanding and a share price of $ 18.09. Quisco is considering developing a new networking product in house at a cost of $ 536 million. Alternatively, Quisco can acquire a firm that already has the technology for $ 887 million worth (at the current price) of Quisco stock. Suppose that absent the expense of the new technology, Quisco will have EPS of $ 0.66. Suppose Quisco does not develop the product in house but instead acquires the technology. What effect would the acquisition have on Quisco's EPS this year? (Note that acquisition expenses do not appear directly on the income statement. Assume the firm was acquired at the start of the year and has no revenues or expenses of its own, so that the only effect on EPS is due to the change in the number of shares outstanding.)

$0.66

You are a shareholder in a C corporation. The corporation earns $ 1.88 per share before taxes. Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. Assume the corporate tax rate is 36 % and the personal tax rate on (both dividend and non-dividend) income is 28 %. How much is left for you after all taxes are paid?

$0.87

A lender lends $10,100 , which is to be repaid in annual payments of $2070 for 6 years. Which of the following shows the timeline of the loan from the lender's perspective?

Dealer

an agent who buys and sells securities from inventory

Super Display Book System

the new server-based electronic trading system at the NYSE

NPV =

PV of benefits - PV of costs

Book Value =

Purchase Price Accumulated Depreciation

In which of the following relationships is an agency conflict problem LEAST likely to arise? A) the relationship between a hire -car company and the persons who hire that company's cars regarding the treatment of those cars B) the relationship between high-level military officers and the soldiers who serve under them regarding the willingness of the soldiery to take risks C) the relationship between a restaurateur and the suppliers of produce to that restaurant regarding the freshness of the produce supplied D) the relationship between a driver and the passengers in a car regarding the safe driving of that car

the relationship between a driver and the passengers in a car regarding the safe driving of that car

You are a shareholder in a C corporation. The corporation earns $ 1.84 per share before taxes. Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. Assume the corporate tax rate is 36 % and the personal tax rate on (both dividend and non-dividend) income is 25 %. How much is left for you after all taxes are paid?

$0.88

Consider again the five-year, $1000 bond with a 2.2% coupon rate and semiannual coupons in Example 6.4. Suppose interest rates drop and the bond's yield to maturity decreases to 2% (expressed as an APR with semiannual compounding). What price is the bond trading for now? And what is the effective annual yield on this bond?

$1,009.47 (1+.01)^2-1=0.0201, or 2.01%

The Sisyphean Company is considering a new project that will have an annual depreciation expense of $3.6 million. If Sisyphean's marginal corporate tax rate is 35% and its average corporate tax rate is 30%, then what is the value of the depreciation tax shield on the company's new project?

$1,260,000 (Here we need to use the marginal tax rate. So, depreciation tax shield = $3.6 million ×0.35 = $1.26 million)

You are a shareholder in a C corporation. The corporation earns $ 2.36 per share before taxes. Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. Assume the corporate tax rate is 38 % and the personal tax rate on (both dividend and non-dividend) income is 20 %. How much is left for you after all taxes are paid?

$1.17

You are a shareholder in an S corporation. The corporation earns $ 1.78 per share before taxes. As a pass through entity, you will receive $ 1.78 for each share that you own. Your marginal tax rate is 25 %. How much per share is left for you after all taxes are paid?

$1.34

You are a shareholder in an S corporation. The corporation earns $ 1.73 per share before taxes. As a pass through entity, you will receive $ 1.73 for each share that you own. Your marginal tax rate is 20 %. How much per share is left for you after all taxes are paid?

$1.38

You are a shareholder in an S corporation. The corporation earns $ 1.93 per share before taxes. As a pass through entity, you will receive $ 1.93 for each share that you own. Your marginal tax rate is 25 %. How much per share is left for you after all taxes are paid?

$1.45

Panjandrum Industries, a manufacturer of industrial piping, is evaluating whether it should expand into the sale of plastic fittings for home garden sprinkler systems. It has made the above estimates of free cash flows resulting from such a decision (all quantities in millions of dollars). There are some concerns that estimates of manufacturing expenses may be low, due to the rising cost of raw materials. What is the break-even point for manufacturing expenses, if all other estimates are correct and the cost of capital is 9%?

$1.66 million (CF0 = -6, CF1 = 1.93 , F1 = 10; calculate NPV at 9% equals 6.38608 ; using TVM keys, PV = 6.38608 , N = 10, I = 9; calculate PMT = 0.99508 . Pre -tax manufacturing expenses = 0.99508 / 0.6 = $1.66 million)

Consider the above Income Statement for CharmCorp. All values are in millions of dollars. If CharmCorp. has 4 million shares outstanding, and its managers and employees have stock options for 2 million shares, what is its diluted EPS in 2008?

$1.67

A firm has an opportunity to invest $95,000 today that will yield $109,250 in one year. If interest rates are 4%, what is the net present value (NPV) of this investment?

$10,048 ($109,250 / (1 +0.04) = $105,048.077; $105,048.077 - $95,000 = $10,048)

Sara wants to have $600,000 in her savings account when she retires. How much must she put in the account now, if the account pays a fixed interest rate of 8%, to ensure that she has $600,000 in 20 years?

$128,729

Refer to the table above. An international seafood supplier is offered 9.52 million yen today for 1000 pounds of abalone frozen in the shell. One thousand pounds of abalone can be sourced from various countries at the prices shown above. The current market exchange rates between the United States and the other relevant currencies are also shown. In addition, $1 U.S. = 102 yen. What is the value, in U.S. dollars, of the best deal the international seafood supplier can make?

$13,333

A firm is considering changing their credit terms. It is estimated that this change would result in sales increasing by $1,600,000. This in turn would cause inventory to increase by $125,000 , accounts receivable to increase by $100,000 , and accounts payable to increase by $90,000 . What is the firm's expected change in net working capital?

$135,000 ($125,000 +$100,000 - $90,000 = $135,000)

Refer to the income statement above. Luther's earnings before interest, taxes, depreciation, and amortization (EBITDA) for the year ending December 31, 2005 is closest to ________.

$135.9 million

A garage is installing a new "bubble-wash" car wash. It will promote the car wash as a fun activity for the family, and it is expected that the novelty of this approach will boost sales in the medium term. If the cost of capital is 10%, what is the net present value (NPV) of this project?

$150,548 (CF1 = -7410 +75,000 + 5,000 = 72,590 ; CF2 and 3 = 90,090 +75,000 + 5,000 = 170,090 ; CF4 = 60,840 +75,000 + 5,000 = 140,840 ; Using a financial calculator, CF0 = -280,000, CF1 = 72,590 , CF2 = 170,090 , CF3 = 170,090 , CF4 = 140,840 ; calculating NPV at 10% = $150,548)

MACRS Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Dep Rate 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% A bakery invests $40,000 in a light delivery truck. This was depreciated using the five-year MACRS schedule shown above. If the company sold it immediately after the end of year 2 for $21,000 , what would be the after-tax cash flow from the sale of this asset, given a tax rate of 40%?

$17,208 (Accumulated depreciation = $40,000 × 0.712 = $28,480 ; book value = $40,000 - $28,480 = $11,520; capital gain = $21,000 - $11,520 = $9480; tax owed = 0.4 ×$9480 = $3792; after-tax cash flow = $21,000 - $3792 = $17,208)

Consider three 30-year bonds with annual coupon payments. One bond has a 10% coupon rate, one has a 5% coupon rate, and one has a 3% coupon rate. If the yield to maturity of each bond is 5%, what is the price of each bond per $100 face value? Which bond trades at a premium, which trades at a discount, and which trades at par?

$176.86 - premium $100.00 - par $69.26 - discount

Consider three 30-year bonds with annual coupon payments. One bond has a 12% coupon rate, one has a 6% coupon rate, and one has a 2% coupon rate. If the yield to maturity of each bond is 6%, what is the price of each bond per $100 face value? Which bond trades at a premium, which trades at a discount, and which trades at par?

$182.59 - premium $100.00 - par $44.94 - discount

Suppose Capital One is advertising a 60-month, 6.25 % APR motorcycle loan. If you need to borrow $ 10 comma 000 to purchase your dream Harley-Davidson, what will be your monthly payment?

$194.49

Consider the above statement of cash flows. If all amounts shown above are in millions of dollars, what were AOS Industries' retained earnings for 2008?

$2.2 million

An investor is considering a project that will generate $900,000 per year for four years. In addition to upfront costs, at the completion of the project at the end of the fifth year there will be shut-down costs of $400,000 . If the cost of capital is 4.4%, based on the MIRR, at what upfront costs does this project cease to be worthwhile?

$2.91 million (Bring all negative cash flows to time 0; thus, PV shut-down cost = -400,000 / (1 +0.044)5 = -$322,520.63; FV positive cash flows at time 5 = $ 4,013,810.7; PV of positive cash flows at time 0 = $3,139,085; NPV at 4.4% = 2.91 million)

The book value of a firm's equity is $100 million and its market value of equity is $200 million. The face value of its debt is $50 million and its market value of debt is $60 million. What is the market value of assets of the firm?

$260 million (Market value of debt plus market value of equity gives market value of assets. $200 + $60 = $260 million)

A C corporation earns $8.30 per share before taxes and the company pays a dividend of $4.00 per share. The corporate tax rate is 39%, the personal tax rate on dividends is 15%, and the personal tax rate on non-dividend income is 36%. What is the after-tax amount an individual would receive from the dividend

$3.40

An investment will pay you $120 in one year and $200 in two years. If the interest rate is 4%, what is the present value of these cash flows?

$300.29

As production manager, you are overseeing the shutdown of a production line for a discontinued product. Some of the equipment can be sold for a total price of $25,000. The equipment was originally purchased 4 years ago for $800,000 and is being depreciated according to the 5-year MACRS schedule. If your marginal tax rate is 40%, what is the after-tax cash flow you can expect from selling the equipment?

$33,432.

In 2009, an agricultural company introduced a new cropping process which reduced the cost of growing some of its crops. If sales in 2008 and 2009 were steady at $30 million, but the gross margin increased from 2.8 % to 3.9 % between those years, by what amount was the cost of sales reduced?

$330,000

A small manufacturer that makes clothespins and other household products buys new injection molding equipment for a cost of $500,000. This will allow the manufacturer to make more clothespins in the same amount of time with an estimated increase in sales of 25%. If the manufacturer currently makes 75 tons of clothespins per year, which sell at $18,000 per ton, what will be the increase in revenue next year from the new equipment?

$337,500 (25% ×75 ×$18,000 = $337,500)

Assume Ford Motors expects a new hybrid-engine project to produce incremental cash flows of $45 million each year, and expects these to grow at 3% each year. The upfront project costs are $380 million and Ford's weighted average cost of capital is 9%. If the issuance costs for external finances are $10 million, what is the net present value (NPV) of the project?

$360 million (PV project cash inflows = $ 45 million / (0.09 - 0.03 ) = $ 750 million; cash outflows = $380 million + $ 10 million = $ 390 million; NPV = $ 750 million - $ 390 million = $360 million)

You have just sold your house for $ 900,000 in cash. Your mortgage was originally a 30-year mortgage with monthly payments and an initial balance of $ 800,000. The mortgage is currently exactly 18½ years old, and you have just made a payment. If the interest rate on the mortgage is 7.75 % (APR), how much cash will you have from the sale once you pay off the mortgage?

$377,589

A firm is considering a new project that will generate cash revenue of $1,300,000 and cash expenses of $700,000 per year for five years. The equipment necessary for the project will cost $300,000 and will be depreciated straight line over four years. What is the expected free cash flow in the second year of the project if the firm's marginal tax rate is 35%?

$416,250 (Annual depreciation = $300,000 / 4 = $75,000 . Free Cash Flow ($1,300,000 - $700,000 - $75,000 ) × (1 - 0.35 ) +$75,000 = $416,250)

As production manager, you are overseeing the shutdown of a production line for a discontinued product. Some of the equipment can be sold for a total price of $50,000. The equipment was originally purchased 4 years ago for $500,000 and is being depreciated according to the 5-year MACRS schedule. If your marginal tax rate is 35%, what is the after-tax cash flow you can expect from selling the equipment?

$42,580

The balance sheet for a small firm is shown above. All amounts are in thousands of dollars. What is this firm's Net Working Capital?

$46 thousand (Current assets - current liabilities = $86 - $40 = $46 thousand)

A firm incurs $70,000 in interest expenses each year. If the tax rate of the firm is 30%, what is the effective after-tax interest rate expense for the firm?

$49,000.00 (Effective after-tax interest expense = Interest expense × (1 - Tax Rate) Effective after-tax interest expense = $70,000 × (1 - 0.3 ) = $49,000.00.)

An auto-parts company is deciding whether to sponsor a racing team for a cost of $1 million. The sponsorship would last for three years and is expected to increase cash flows by $570,000 per year. If the discount rate is 6.9 %, what will be the change in the value of the company if it chooses to go ahead with the sponsorship?

$498,597 (: NPV = -1,000,000 +570,000 / (1 +0.069 ) +570,000 / (1 +0.069 )2 +570,000 / (1 +0.069 )3 = $498,597)

SAP Inc. received a $1.5 million grant under its Small Business Innovation program. SAP invested the grant money and developed a system to remove metal contaminants from storm water in shipyards. The firm estimates that each shipyard spends $500,000 a year on storm water clean-up efforts. If SAP is able to sign up and retain four shipyards in the first year onwards, what is the present value (PV) of the project (net of investment) if the cost of capital for SAP is 14% per year? Assume a cost of operations and other costs for SAP equal 50% of revenue.

$5.64 million (Net present value = -Investment + Present Value of (Revenues × (1 - proportion of costs)) Net present value = -$1.5 million + ($2 million × (1 - 0.5 )) / 0.14 = $5.6 million)

Assume Ford Motors expects a new hybrid-engine project to produce incremental cash flows of $50 million each year, and expects these to grow at 4% each year. The upfront project costs are $420 million and Ford's weighted average cost of capital is 9%. If the issuance costs for external finances are $20 million, what is the net present value (NPV) of the project?

$560 million (PV project cash inflows = $ 50 million / (0.09 - 0.04) = $ 1000 million; Cash outflows = $420 million + $ 20 million = $ 440 million; NPV = $ 1000 million - $ 440 million = $560 million)

Over four-fifths of all U.S. business revenue is generated by which type of firms?

corporations

A fertilizer company can create a new environmentally friendly fertilizer at a large savings over the company's existing fertilizer The fertilizer will require a new factory that can be built at a cost of $81.6 million. Estimated return on the new fertilizer will be $28 million after the first year, and will last for four years Computing NPV

$7.2 million

After saving $1,500 waiting tables, you are about to buy a 50-inch LCD TV. You notice that the store is offering "one-year same as cash" deal. You can take the TV home today and pay nothing until one year from now, when you will owe the store the $1,500 purchase price. If your savings account earns 5% per year, what is the NPV of this offer? Show that its NPV represents cash in your pocket.

$71.43

Consider again the nine-year, $1000 bond with a 3% coupon rate and semiannual coupons in Example 6.4a. •Suppose interest rates increase and the bond's yield to maturity increases to 4.0% (expressed as an APR with semiannual compounding). •What price is the bond trading for now?

$925.04 (1+0.02)^2-1 = .0404, or 4.04%

After saving $2,500 waiting tables, you are about to buy a 50-inch LCD TV. You notice that the store is offering "one-year same as cash" deal. You can take the TV home today and pay nothing until one year from now, when you will owe the store the $2,500 purchase price. If your savings account earns 4% per year, what is the NPV of this offer? Show that its NPV represents cash in your pocket.

$96.15

Equivalent n-Period Discount Rate

(1 + r)^n - 1

Incremental Earnings =

(Incremental Revenues - Incremental Costs - Depreciation) x (1 - Tax Rate)

You own 1000 shares of Newstar Financial stock, currently trading for $57 per share. You are offered a deal where you can exchange these stocks for 900 shares of Amback Financial Group stock, currently trading at $63 per share. What is the value of this trade, if you choose to make it?

-$300

A company buys a color printer that will cost $16,000 to buy, and last 5 years. It is assumed that it will require servicing costing $500 each year. What is the equivalent annual annuity of this deal, given a cost of capital of 8%? A) -$4507 B) -$4057 C) -$3606 D) -$3155

-$4507 (NPV = -$17,996 equivalent annual annuity = -$4507

The NPV depends on

cost of capital

Weakness of the Payback Rule

-Ignores the time value of money -Ignores cash-flows after the payback period -Lacks a decision criterion grounded in economics

Weakness in IRR

-In most cases IRR rule agrees with NPV for stand-alone projects if all negative cash flows precede positive cash flows -In other cases the IRR may disagree with NPV

Consider the following two projects: Project 0 1 2 3 4 Disc. Rate A -100 40 50 60 N/A 0.16 B -73 30 30 30 30 0.16 The profitability index for project B is closest to ________.

0.15 (PI = NPV / Investment (or resources consumed) NPV = -73 + 30 / (1 +0.16 )1 + 30 / (1 +0.16 )2 + 30 / (1 +0.16 )3 + 30 / (1 +0.16 )4 = 10.9454191 So, PI = 10.9454191 / 73 = 0.1499)

Assume Lavender Corporation has a market value of $4 billion of equity and a market value of $19.8 billion of debt. What are the weights in equity and debt that are used for calculating the WACC?

0.168, 0.832 (Weight in debt equals market value of debt divided by market value of debt plus equity. Similarly, weight in equity is market value of equity divided by market value of debt plus equity. Weight in equity = $ 4 billion / ($4 + $ 19.8 ) billion = 0.168 ; Weight in debt = $ 19.8 billion / ($4 + $ 19.8 ) billion = 0.832)

JPJ Corp has sales of $ 1.49 million, accounts receivable of $ 55 comma 000, total assets of $ 4.82 million (of which $ 3.18 million are fixed assets), inventory of $ 156 comma 000, and cost of goods sold of $ 602 comma 000. Total asset turnover?

0.31

Assume the yield to maturity on Amazon's debt that matures in 2 years is 0.65%. If Amazon's tax rate is 39%, what is its effective cost of debt?

0.397%

0.47

Refer to the balance sheet above. Luther's quick ratio for 2006 is closest to ________.

0.87

In December 2015, Apple had cash of $ 38.22 billion, current assets of $ 75.74 billion, and current liabilities of $ 76.38 billion. It also had inventories of $ 2.45 billion. b. What was Apple's quick ratio?

0.96

In December 2015, Apple had cash of $ 38.22 billion, current assets of $ 75.74 billion, and current liabilities of $ 76.38 billion. It also had inventories of $ 2.45 billion. a. What was Apple's current ratio? b. What was Apple's quick ratio? c. In January 2016, Hewlett-Packard had a quick ratio of 0.66 and a current ratio of 0.90. What can you say about the asset liquidity of Apple relative to Hewlett-Packard?

0.99

Consider the nine-year, $1000 note with a 3% coupon rate and semiannual coupons described in Example 6.3a. If this bond is currently trading for a price of $1,038.32, what is the bond's yield to maturity?

1.26%

Consider the five-year, $1000 bond with a 2.2% coupon rate and semiannual coupons described in Example 6.3. If this bond is currently trading for a price of $963.11, what is the bond's yield to maturity?

1.50%

Refer to the balance sheet above. If in 2006 Luther has 10.2 million shares outstanding and these shares are trading at $16 per share, then using the market value of equity, the debt-equity ratio for Luther in 2006 is closest to ________.

1.72

By using the yield to maturity on DuPont's debt, we found that its pre-tax cost of debt is 2.81%. If DuPont's tax rate is 35%, what is its effective cost of debt?

1.827%

Factors to consider when estimating a project's revenues and costs:

1.A new product typically has lower sales initially 2.The average selling price of a product and its cost of production will generally change over time 3.For most industries, competition tends to reduce profit margins over time

Capital Asset Pricing Model

1.Estimate the firm's beta of equity, typically by regressing 60 months of the company's returns against 60 months of returns for a market proxy such as the S&P 500 2.Determine the risk-free rate, typically by using the yield on Treasury bills or bonds 3.Estimate the market risk premium, typically by comparing historical returns on a market proxy to contemporaneous risk-free rates 4.Apply the CAPM:

If the rate of inflation is 6.2 %, what nominal interest rate is necessary for you to earn a 4.1 % real interest rate on your investment?

10.55%

Local Co. has sales of $ 10.5 million and cost of sales of $ 5.8 million. Its selling, general and administrative expenses are $ 470 comma 000 and its research and development is $ 1.1 million. It has annual depreciation charges of $ 1.1 million and a tax rate of 35 %. c. What is Local's net profit margin?

12.57%

Assume IBM just paid a dividend of $4.50 and expects these dividends to grow at 8% a year. The price of IBM is $100 per share. What is IBM's cost of equity capital?

12.86 % (Cost of equity is the next period dividend divided by the price plus the growth rate in dividends. Cost of equity = (Div 1 / PE) +g = ($4.50 ×1.08 ) / $100 +0.08 = 0.1286 = 12.86 %)

Lengefeld Manufacturing expects to have earnings per share of $1.80 in the coming year. Rather than reinvest these earnings and grow, the firm plans to pay out all of its earnings as a dividend. With these expectations of no growth, Lengefeld's current share price is $24. Suppose Lengefeld could cut its dividend payout rate to 50% for the foreseeable future and use the retained earnings to open an additional factory. The return on investment in the new factory is expected to be 15%. If we assume that the risk of the new factory is the same as the risk of its existing factories, then the firm's equity cost of capital is unchanged. What effect would this new policy have on Lengefeld's stock price?

120.48

Two mutually exclusive investment opportunities require an initial investment of $7 million. Investment A pays $2.0 million per year in perpetuity, while investment B pays $1.4 million in the first year, with cash flows increasing by 4% per year after that. At what cost of capital would an investor regard both opportunities as being equivalent? A) 7% B) 3% C) 13% D) 15%

13% (-7 +2.0 / r = -7 + 1 / (r - 0.04); r = 13%)

13.47

Your estimate of the market risk premium is 7%. The risk-free rate of return is 4% and General Motors has a beta of 1.6 . What is General Motors' cost of equity capital?

15.2% (Apply the CAPM equation. Cost of equity = 0.04 + (1.6 ×0.07) = 0.152 = 15.2%)

Solve for the crossover point for the following two projects. Expected Net Cash Flow Year Project A Project B 0 -$12,000 -$10,000 1 $5,000 $4,100 2 $5,000 $4,100 3 $5,000 $4,100

16.65%.

Small Fry, Inc., has just invented a potato chip that looks and tastes like a french fry. Given the phenomenal market response to this product, Small Fry is reinvesting all of its earnings to expand its operations. Earnings were $5 per share this past year and are expected to grow at a rate of 30% per year until the end of year 3. At that point, other companies are likely to bring out competing products. Analysts project that at the end of year 3, Small Fry will cut its investment and begin paying 75% of its earnings as dividends. Its growth will also slow to a long-run rate of 5%. If Small Fry's equity cost of capital is 9%, what is the value of a share today?

173.39

19.3%

Chutes & Co. has interest expense of $ 1.62 million and an operating margin of 11.3 % on total sales of $ 29.9 million. What is Chutes' interest coverage ratio?

2.1

Refer to the balance sheet above. When using the book value of equity, the debt-equity ratio for Luther in 2006 is closest to ________.

2.25

Suppose Lengefeld Manufacturing decides to cut its dividend payout rate to 50% to invest in new stores, as in Example 7.3b. But now suppose that the return on these new investments is 8%, rather than 15%. Give its expected earnings per share this year of $2 and its equity cost of capital of 8.33% (we again assume that the risk of the new investments is the same as its existing investments), what will happen to Lengefeld's current share price in this case?

23.09

Suppose Kenai Corp. has debt with a book (face) value of $10 million, trading at 95% of face value. It also has book equity of $10 million, and 1 million shares of common stock trading at $30 per share. What weights should Kenai use in calculating its WACC?

24.1% for debt 75.9% for equity

Refer to the income statement above. Luther's return on assets (ROA) for the year ending December 31, 2005 is closest to ________.

24.32%

Suppose McDonalds Inc. has debt with a market value of $18 billion outstanding, and a with a common stock market value of $52 billion, and a book value of $36 billion. Which weights should McDonalds use in calculation of its WACC?

25.7% for debt 74.3% for equity

Suppose 3M Corp. has debt with a book (face) value of $25 million, trading at 110% of face value. It also has book equity of $35 million, and 3 million shares of common stock trading at $25 per share. What weights should 3M use in calculating its WACC?

26.8% for debt 73.2% for equity

Pittsburgh & West Virginia Railroad (PW) expects to have earnings per share of $0.48 in the coming year. Rather than reinvest these earnings and grow, the firm plans to pay out all of its earnings as a dividend. With these expectations of no growth, PW's current share price is $10. Suppose PW could cut its dividend payout rate to 67% for the foreseeable future and use the retained earnings to expand. The return on investment in the expansion is expected to be 11%. If we assume that the risk of these new investments is the same as the risk of its existing investments, then the firm's equity cost of capital is unchanged. What effect would this new policy have on PW's stock price?

27.35

Assume that Linksys's managers believe that the HomeNet project has risks similar to its existing projects, for which it has a cost of capital of 12%. Compute the NPV of the HomeNet project.

2862

Martin is offered an investment where for $6000 today, he will receive $6180 in one year. He decides to borrow $6000 from the bank to make this investment. What is the maximum interest rate the bank needs to offer on the loan if Martin is at least to break even on this investment?

3% (($6180 - $6000) / $6000 = 3%)

3.86

Suppose The Walt Disney Company plans to pay $0.38 per share in dividends in the coming year. If its equity cost of capital is 10.6% and dividends are expected to grow by 9.5% per year in the future, estimate the value of Disney's stock.

34.55

By using yield to maturity on Gap Inc.'s debt, we find that its pre-tax cost of debt is 7.13%. If Gap Inc.'s tax rate is 40%, what is its effective cost of debt?

4.28%

Assume JUP has debt with a book value of $24 million, trading at 120% of par value. The firm has book equity of $28 million, and 2 million shares trading at $20 per share. What weights should JUP use in calculating its WACC?

41.86 % for debt, 58.14% for equity (Market Value Debt = $24 million × 120% = $28.8 million Market Value Equity = 2 million ×$20 = $40 million Total Market Value = $68.8 million Weight of debt = $28.8 million / $68.8 million = 41.86 % Weight of equity = $40 million / $68.8 million = 58.14%)

Suppose Target Corporation plans to pay $0.68 per share in dividends in the coming year. If its equity cost of capital is 10% and dividends are expected to grow by 8.4% per year in the future, estimate the value of Target's stock.

42.50

Suppose you expect Longs Drug Stores to pay an annual dividend of $0.56 per share in the coming year and to trade $45.50 per share at the end of the year. If investments with equivalent risk to Longs' stock have an expected return of 6.80%, what is the most you would pay today for Longs' stock? What dividend yield and capital gain rate would you expect at this price?

43.13

44.8%

Consolidated Edison, Inc. (Con Edison), is a regulated utility company that services the New York City area. Suppose Con Edison plans to pay $2.30 per share in dividends in the coming year. If its equity cost of capital is 7% and dividends are expected to grow by 2% per year in the future, estimate the value of Con Edison's stock.

46.00

Small Fry, Inc., has just invented a potato chip that looks and tastes like a french fry. Given the phenomenal market response to this product, Small Fry is reinvesting all of its earnings to expand its operations. Earnings were $2 per share this past year and are expected to grow at a rate of 20% per year until the end of year 4. At that point, other companies are likely to bring out competing products. Analysts project that at the end of year 4, Small Fry will cut its investment and begin paying 60% of its earnings as dividends. Its growth will also slow to a long-run rate of 4%. If Small Fry's equity cost of capital is 8%, what is the value of a share today?

49.42

Suppose Crane Supporting Goods decides to cut its dividend payout rate to 75% to invest in new stores, as in Example 7.3. But now suppose that the return on these new investments is 8%, rather than 12%. Give its expected earnings per share this year of $6 and its equity cost of capital of 10% (we again assume that the risk of the new investments is the same as its existing investments), what will happen to Crane's current share price in this case?

56.25

Martin is offered an investment where for $4000 today, he will receive $4240 in one year. He decides to borrow $4000 from the bank to make this investment. What is the maximum interest rate the bank needs to offer on the loan if Martin is at least to break even on this investment?

6% (($4240 - $4000) / $4000 = 6%)

Assume the equity beta for Johnson & Johnson (ticker: JNJ) is 0.55. The yield on 10-year treasuries is 3%, and you estimate the market risk premium to be 6%. Furthermore, Johnson & Johnson issues dividends at an annual rate of $2.81. Its current stock price is $92.00, and you expect dividends to increase at a constant rate of 4% per year. Estimate J&J's cost of equity in two ways.

6.3% OR 7.1%

Suppose you expect Harford Industries to pay an annual dividend of $5.35 per share in the coming year and to trade $63.32 per share at the end of the year. If investments with equivalent risk to Harford's stock have an expected return of 12.5%, what is the most you would pay today for Harford's stock? What dividend yield and capital gain rate would you expect at this price?

61.04

Crane Sporting Goods expects to have earnings per share of $6 in the coming year. Rather than reinvest these earnings and grow, the firm plans to pay out all of its earnings as a dividend. With these expectations of no growth, Crane's current share price is $60. Suppose Crane could cut its dividend payout rate to 75% for the foreseeable future and use the retained earnings to open new stores. The return on investment in these stores is expected to be 12%. If we assume that the risk of these new investments is the same as the risk of its existing investments, then the firm's equity cost of capital is unchanged. What effect would this new policy have on Crane's stock price?

64.29

Assume Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its current capital structure has a 25% weight in equity, 10% in preferred stock, and 65% in debt. The cost of equity capital is 13%, the cost of preferred stock is 9%, and the pretax cost of debt is 8%. What is the weighted average cost of capital for Ford if its marginal tax rate is 40%?

7.27% (rwacc = rEE% +rD (1 - Tc) D% +rpfdP% rwacc = 0.25 ×0.13 +0.65 ×0.08 × (1 - 0.4) +0.1 ×0.09 = 0.0727 = 7.27%)

The outstanding debt of Berstin Corp. has ten years to maturity, a current yield of 7%, and a price of $95. What is the pretax cost of debt if the tax rate is 30%.

7.37% (Current yield = coupon / price; 0.07 = coupon / 95; hence, coupon = 0.07 × 95 = 6.65; yield to maturity = pretax cost of debt; using a financial calculator, -95 PV, 100 FV, 6.65 PMT, 10 N, CPT I = 7.37%)

If the rate of inflation is 4.1 %, what nominal interest rate is necessary for you to earn a 3.4 % real interest rate on your investment?

7.64%

Solve for the crossover point for the following two projects. Expected Net Cash Flow Year Project A Project B 0 -$12,000 -$20,000 1 $5,000 $8,100 2 $5,000 $8,100 3 $5,000 $8,100

7.92%

3M Co. has 698 million shares outstanding and expects earnings at the end of this year of $2.96 billion. 3M plans to pay out 50% of its earnings in total, paying 25% as a dividend and using 25% to repurchase shares. If 3M's earnings are expected to grow by 9.2% per year and these payout rates remain constant, determine 3M's share price assuming an equity cost of capital of 12%.

75.73

Suppose you expect Koch Industries to pay an annual dividend of $2.31 per share in the coming year and to trade $82.75 per share at the end of the year. If investments with equivalent risk to Koch's stock have an expected return of 8.9%, what is the most you would pay today for Koch's stock? What dividend yield and capital gain rate would you expect at this price?

78.11

Titan Industries has 217 million shares outstanding and expects earnings at the end of this year of $860 million. Titan plans to pay out 50% of its earnings in total, paying 30% as a dividend and using 20% to repurchase shares. If Titan's earnings are expected to grow by 7.5% per year and these payout rates remain constant, determine Titan's share price assuming an equity cost of capital of 10%.

79.26

Suppose Pittsburgh & West Virginia Railroad decides to cut its dividend payout rate to 67% to invest in new stores, as in Example 7.3a. But now suppose that the return on these new investments is 4%, rather than 11%. Give its expected earnings per share this year of $0.48 and its equity cost of capital of 4.8% (we again assume that the risk of the new investments is the same as its existing investments), what will happen to PW's current share price in this case?

9.20

Assume the market value of Fords' equity, preferred stock and debt are $6 billion, $3 billion, and $13 billion, respectively. Ford has a beta of 1.7, the market risk premium is 8%, and the risk-free rate of interest is 3%. Ford's preferred stock pays a dividend of $2.50 each year and trades at a price of $30 per share. Ford's debt trades with a yield to maturity of 9.5 %. What is Ford's weighted average cost of capital if its tax rate is 35%?

9.31% (Cost of equity is the next period dividend divided by the price plus the growth rate in dividends. Cost of debt is the yield to maturity times one minus the tax rate. WACC is the weight of debt times cost of debt plus weight of equity times cost of equity. Cost of equity = 0.03 +1.7 ×0.08 = 0.166 ; Cost of debt = 0.095 × (1 - 0.35 ) = 0.06175 ; Cost of preferred stock = $ 2.50 / $30 = 0.08333333 ; WACC = $ 6 billion ×0.166 / $22 billion + $ 3 billion ×0.08333333 / $22 billion + $ 13 billion ×0.06175 / 22 = 0.09313 or 9.31%)

SIROM Scientific Solutions has $12 million of outstanding equity and $4 million of bank debt. The bank debt costs 4% per year. The estimated equity beta is 1. If the market risk premium is 8% and the risk-free rate is 4%, compute the weighted average cost of capital if the firm's tax rate is 30%.

9.70 % (Cost of debt = rate on bank debt Cost of equity = Risk-free rate +Beta ×Market risk premium Weight of equity = Outstanding equity / (Outstanding equity +Debt) Weight of debt = 1- Weight of equity. rwacc = rEE% +rD (1 - Tc) D% Cost of equity = 0.04 + 1 ×0.08 = 0.12 or 12% Weight of equity= 12/(12 +4) = 0.75 or 75% Weight of debt = 1 - 0.75 = 0.25 or 25% WACC = 0.75 ×0.12 +0.25 ×0.04 × (1 - 0.3 ) = 9.70 %)

Net Working Capital

= Current Assets x Current Liabilities = Cash + Inventory + Receivables x Payables

Sensitivity Analysis

A capital budgeting tool that determines how the NPV varies as a single underlying assumption is changed

bond

A financial security that represents a promise to repay a fixed amount of funds

bond certificate

A legal document that indicates the name of the issuer, the face value of the bonds, and other data such as the contractual interest rate and the maturity date of the bonds.

Why should you approach every problem by drawing a timeline?

A timeline identifies events in a transaction or investment which might otherwise be easily overlooked.

The NPV decision rule implies that we should:

Accept positive-NPV projects; accepting them is equivalent to receiving their NPV in cash today, and Reject negative-NPV projects; accepting them would reduce the value of the firm, whereas rejecting them has no cost (NPV = 0)

Consider the following potential events that might have occurred to Global on December 30, 2016. For each one, indicate which line items in Global's balance sheet would be affected and by how much. Also indicate the change to Global's book value of equity. A large customer owing $ 3.0 million for products it already received declared bankruptcy, leaving no possibility that Global would ever receive payment.

Accounts receivable would decrease by $ 3.0 million, as would the book value of equity.

Tax Loss Carryforwards/Tax Loss Carrybacks

Allow corporations to take losses during a current year and offset them against gains in nearby years

face value

Amount of principal due at the maturity date of the bond

Which of the following statements regarding the Law of One Price is INCORRECT? A) If equivalent goods or securities trade simultaneously in different competitive markets, then they will trade for the same price in both markets. B) At any point in time, the price of two equivalent goods trading in different competitive markets will be the same. C) One useful consequence of the Law of One Price is that when evaluating costs and benefits to compute a net present value (NPV), we can use any competitive price to determine a cash value, without checking the price in all possible markets. D) An important property of the Law of One Price is that it holds even in markets where arbitrage is possible.

An important property of the Law of One Price is that it holds even in markets where arbitrage is possible.

In December 2015, Apple had cash of $ 38.22 billion, current assets of $ 75.74 billion, and current liabilities of $ 76.38 billion. It also had inventories of $ 2.45 billion. c. In January 2016, Hewlett-Packard had a quick ratio of 0.66 and a current ratio of 0.90. What can you say about the asset liquidity of Apple relative to Hewlett-Packard?

Apple's higher current and quick ratios demonstrate that it has much higher asset liquidity than does Hewlett-Packard. This means that in a pinch, Apple has more liquidity to draw on than does Hewlett-Packard.

Which of the following would be best considered to be an agency conflict problem in the behavior of the following financial managers? A) Michael chooses to enhance his firm's reputation at some cost to its shareholders by sponsoring a team of athletes for the Olympics. B) Bill chooses to pursue a risky investment for the company's funds because his compensation will substantially rise if it succeeds. C) Sue instructs her staff to skip safety inspections in one of the company's factories, knowing that it will likely fail the inspection and incur significant costs to fix. D) James ignores an opportunity for his company to invest in a new drug to fight Alzheimer's disease, judging the drug's chances of succeeding as low.

Bill chooses to pursue a risky investment for the company's funds because his compensation will substantially rise if it succeeds.

Suppose your firm receives a $ 5.12 million order on the last day of the year. You fill the order with $ 1.85 million worth of inventory. The customer picks up the entire order the same day and pays $ 1.15 million up front in cash; you also issue a bill for the customer to pay the remaining balance of $ 3.97 million within 40 days. Suppose your firm's tax rate is 0 % (i.e., ignore taxes). Determine the consequences of this transaction for each of the following: e. Cash

Cash will increase by $1.15 million.

Income Tax =

EBIT x The Firm's Marginal Corporate Tax Rate

Earnings will increase by $3.27 million.

Corporate managers work for the owners of the corporation. Consequently, they should make decisions that are in the interests of the owners, rather than in their own interests. What strategies are available to shareholders to help ensure that managers are motivated to act this way?

Ensure that underperforming managers are fired. Mount hostile takeovers. Ensure that employees are paid with company stock and/or stock options. Write contracts that ensure that the interests of the managers and shareholders are closely aligned.

Which of the following statements is FALSE? A) Issuance costs increase the WACC. B) Issuance costs should be treated as cash outflows in NPV analysis. C) External equity is less expensive than retained earnings. D) A project that can be financed with internal funds will be less costly than the same project if it were financed with external funds.

External equity is less expensive than retained earnings.

In December 2015, General Electric (GE) had a book value of equity of $ 97.2 billion, 9.2 billion shares outstanding, and a market price of $ 28.47 per share. GE also had cash of $ 102.1 billion, and total debt of $ 200.2 billion. b. What was GE's book debt-equity ratio? What was GE's market debt-equity ratio?

GE's book debt-equity ratio was 2.06. GE's market debt-equity ratio was 0.76.

GE's enterprise value was $360.0 billion.

In December 2015, General Electric (GE) had a book value of equity of $ 97.2 billion, 9.2 billion shares outstanding, and a market price of $ 28.47 per share. GE also had cash of $ 102.1 billion, and total debt of $ 200.2 billion. a. What was GE's market capitalization? What was GE's market-to-book ratio?

GE's market capitalization was $261.9 billion. GE's market-to-book ratio was 2.69.

According to Graham and Harvey's 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are ________.

IRR, NPV, Payback period

What are the main disadvantages of organizing a firm as a C corporation?

Income to a C corporation is subject to double taxation, once at the corporate level and again when received by the owners in the form of a dividend. The C corporation is more complicated and more expensive to set up than other business entities.

Incremental Earnings Before Interest and Taxes (EBIT) =

Incremental Revenue - Incremental Costs - Depreciation

Annual Percentage Rate (APR)

Indicates the amount of simple interest earned in one year, that is the amount of without the effect of compounding

Inventory will decrease by $1.85 million.

Consider the following potential events that might have occurred to Global on December 30, 2016. For each one, indicate which line items in Global's balance sheet would be affected and by how much. Also indicate the change to Global's book value of equity. A warehouse fire destroyed $ 5.0 million worth of uninsured inventory.

Inventory would decrease by $ 5.0 million, as would the book value of equity.

What role do investment banks play in the economy?

Investment banks advise companies in major financial transactions such as buying or selling companies or divisions. Investment banks assist companies in raising capital by issue of stocks and bonds on behalf of corporate clients.

Which of the following is a way that the operating activity section of the statement of cash flows adjusts Net Income from the balance sheet? A) It removes the cash used for investment purposes. B) It subtracts all expenses and costs related to a firm's operating activities. C) It adds the cash that flows from investors to a firm. D) It adds all non-cash entries related to a firm's operating activities.

It adds all non-cash entries related to a firm's operating activities.

The firm can increase its dividend in three ways

It can increase its earnings It can increase its dividend payout rate It can decrease its number of shares outstanding

Which of the following is NOT a limitation of the payback rule? A) It is difficult to calculate. B) It does not consider the time value of money. C) It does not consider cash flows occurring after the payback period. D) Lacks a decision criterion that is economically based.

It is difficult to calculate.

What is the main reason that it is necessary for public companies to follow the rules and format set out in the Generally Accepted Accounting Principles (GAAP) when creating financial statements?

It makes it easier to compare the financial results of different firms.

Which of the following best describes why the Valuation Principle is a key concept in making financial decisions? A) It allows fixed assets and liquid assets to be valued correctly. B) It shows how to make the costs and benefits of a decision comparable so that we can weigh them properly. C) It shows how to assign monetary value to intangibles such as good health and well-being. D) It gives a good indication of the net worth of a person, item, or company and can be used to estimate any changes in that net worth.

It shows how to make the costs and benefits of a decision comparable so that we can weigh them properly

Job Hours to Print Job Penalty Job A 6 -$120 Job B 9 -$200 Job C 12 -$360 Job D 16 -$400 Job E 2 -$50 A print shop has contracted to print a number of jobs within 24 hours. Any jobs not completely printed within this time will result in a penalty, as shown in the table above. However too many jobs have been accepted, and not all can be printed. Which jobs should be printed in the next 24 hours? A) Job D, Job A, and Job E B) Job C and Job B C) Job D and Job A D) Job C, Job B, and Job E

Job C, Job B, and Job E

Consider the following potential events that might have occurred to Global on December 30, 2016. For each one, indicate which line items in Global's balance sheet would be affected and by how much. Also indicate the change to Global's book value of equity. Global used $ 5.0 million in cash and $ 5.0 million in new long-term debt to purchase a $ 10.0 million building.

Long-term assets would increase by $ 10.0 million, cash would decrease by $ 5.0 million, and long-term liabilities would increase by $ 5.0 million. There would be no change to the book value of equity.

Consider the following potential events that might have occurred to Global on December 30, 2016. For each one, indicate which line items in Global's balance sheet would be affected and by how much. Also indicate the change to Global's book value of equity. Global used $ 20.0 million of its available cash to repay $ 20.0 million of its long-term debt.

Long-term liabilities would decrease by $ 20.0 million, and cash would decrease by the same amount. The book value of equity would be unchanged.

Tanner is choosing between two investment options. He can invest $500 now and get (guaranteed) $550 in one year, or invest $500 now and get (guaranteed) $531.40 back later today. The risk-free rate is 3.5%. Which investment should Tanner prefer? A) $531.40 later today, since $1 today is worth more than $1 in one year. B) $550 in one year, since it is $50 more than he invested rather than $31.40 more than he invested. C) Neither - both investments have a negative NPV. D) Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.

Neither - both investments have a negative NPV. (The NPVs are equal, so that each is the same as $31.40 today)

Heavy Duty Company, a manufacturer of power tools, decides to offer a rebate of $130 on its 16-inch mid-range chain saw, which currently has a retail price $490. Heavy Duty's marketers estimate that, as a result of the rebate, sales of this model will increase from 60,000 to 80,000 units next year. The profit margin for Heavy Duty before the rebate is $180. Based on the given information, is the decision to give the rebate a wise one?

No, since costs are $6,800,000 more than benefits.

zero-coupon bonds

Only two cash flows • The bond's market price at the time of purchase • The bond's face value at maturity

If WiseGuy Inc. uses payback period rule to choose projects, which of the projects (Project A or Project B) will rank highest? Project A Project B Time 0 -10,000 -10,000 Time 1 5,000 4,000 Time 2 4,000 3,000 Time 3 3,000 10,000

Project B

When choosing between two projects, assume a company chooses the one with the lowest payback period. Which of the following two projects would the firm undertake the project under this rule? Year Project A Project B 0 -$10,000 -$10,000 1 $1,000 $5,000 2 $1,000 $5,000 3 $8,000 $5,000 4 $1,000,000 $5,000

Project B will be chosen

Which of the following statements regarding real options is NOT correct? A) Real options should only be exercised when they increase the NPV of a project. B) Real options give owners the right, but not the obligation, to exercise these opportunities at a later date. C) Real options build greater flexibility into a project and thus increase its net present value (NPV). D) Real options enhance the forecast of a project's expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date.

Real options enhance the forecast of a project's expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date.

Receivables will increase by $3.97 million.

Revenues will increase by $5.12 million.

Cost of Equity =

Risk-Free Rate + Equity Beta × Market Risk Premium

Mary is in contract negotiations with a publishing house for her new novel. She has two options. She may be paid $100,000 up front, and receive royalties that are expected to total $26,000 at the end of each of the next five years. Alternatively, she can receive $200,000 up front and no royalties. Which of the following investment rules would indicate that she should take the former deal, given a discount rate of 8%? Rule I: The Net Present Value rule Rule II: The Payback Rule with a payback period of two years Rule III: The internal rate of return (IRR) Rule A) Rule II and III B) Rule I and II C) Rule III only D) Rule I only

Rule I only (CF0 = 100,000, CF1 = 26,000, F1 = 5; calculate NPV for I = 8 = $203,810, which is greater than $200,000)

Which of the following is a measure of the aggregate price level of collections of pre -selected stocks? A) NASDAQ B) S&P 500 C) Euronext D) NYSE

S&P 500

After-Tax Cash Flow from Asset Sale =

Sale Price x (Tax Rate x Capital Gain)

Capital Gain =

Sale Price x Book Value

coupon rate

Set by the issuer and stated on the bond certificate

A small company has current assets of $112,000 and current liabilities of $117,000. Which of the following statements about that company is most likely to be true?

Since net working capital is negative, the company will not have enough funds to meet its obligations

The Internal Rate of Return Rule

Take any investment opportunity where IRR exceeds the opportunity cost of capital

Which of the following best describes the Net Present Value rule? A) When choosing among any list of investment opportunities where resources are limited, always choose those projects with the highest net present value (NPV). B) Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative. C) If the difference between the present cost of an investment and the present value (PV) of its benefits after a fixed number of years is positive the investment should be taken, otherwise it should be rejected. D) Take any investment opportunity where the net present value (NPV) exceeds the opportunity cost of capital; turn down any opportunity where the cost of capital exceeds the net present value (NPV)

Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative.

Common Stock

Term used to describe the total amount paid in by stockholders for the shares they purchase.

What is the difference between a primary and a secondary market?

The primary market refers to a corporation issuing new shares of stock and selling them to investors. After this initial transaction between the corporation and investors, the shares continue to trade in a secondary market between investors without the involvement of the corporation.

If the above balance sheet is for a retail company, what indications about this company would best be drawn from the changes in the balance sheet between 2007 and 2008?

The company is having difficulties selling its product.

If the above balance sheet is for a retail company, what indications about this company would best be drawn from the changes in stockholders' equity between 2007 and 2008?

The company's net income in 2008 was negative.

A software company acquires a smaller company in order to acquire the patents that it holds. Where will the cost of this acquisition be recorded on the statement of cash flows?

as an outflow under investment activities

Trade Credit

The difference between receivables and payables is the net amount of the firm's capital that is consumed as a result of these credit transactions

You are considering two ways of financing a spring break vacation. You could put it on your credit card, at 14 % APR, compounded monthly, or borrow the money from your parents, who want an interest payment of 9 % every six months. Which is the lower rate?

The effective annual rate for your credit card is 14.93%. The effective annual rate for the loan from your parents is 18.81%. The option with the lower effective annual rate is your credit card .

You are considering two ways of financing a spring break vacation. You could put it on your credit card, at 17 % APR, compounded monthly, or borrow the money from your parents, who want an 9 % interest payment every six months. Which is the lower rate?

The effective annual rate for your credit card is 18.39 %. The effective annual rate for the loan from your parents is 18.81 %. Therefore, your credit card has the lower effective annual rate

Incremental Revenue and Cost Estimates

The evaluation is on how the project will change the cash flows of the firm

What is the most important type of decision that the financial manager makes?

The financial manager's most important job is to make the firm's investment decisions.

A lawn maintenance company compares two ride -on mowersthe Excelsior, which has an expected working-life of six years, and the Grassassinator, which has a working life of four years. After examining the equivalent annual annuities of each mower, the company decides to purchase the Excelsior. Which of the following, if true, would be most likely to make them change that decision? A) The mower is only expected to be needed for three years. B) The number of customers requiring lawn-mowing services is expected to sharply increase in the near future. C) Fuel prices are expected to rise and raise the annual running costs of all mowers. D) The prices of equivalent mowers are expected to grow in the future as lawnmower manufacturers consolidate.

The mower is only expected to be needed for three years.

Round Lot

The number of shares being traded is at least 100.

What is the major way in which the roles and obligations of the owners of a limited liability company differ from the roles and obligations of limited partners in a limited partnership?

The owners of a limited liability company can take an active role in running the company

Consider a 10-year coupon bond and a 30-year coupon bond, both with 10% annual coupons. By what percentage will the price of each bond change if its yield to maturity increases from 5% to 6%?

The price of the 10-year bond changes by (129.44 - 138.61) / 138.61 = -6.6% if its yield to maturity increases from 5% to 6%. For the 30-year bond, the price change is (155.06 - 176.86) / 176.86 = -12.3%.

Consider a 5-year coupon bond and a 40-year coupon bond, both with 5% annual coupons. By what percentage will the price of each bond change if its yield to maturity increases from 5% to 6%?

The price of the 5-year bond changes by (95.79-100)/100=-4.2% if its yield to maturity increases from 5% to 6%. For the 40-year bond, the price change is (84.95-100) /100 = -15.1%.

Assume Frederick's requires all projects to have a payback period of two years or less. Would the firm undertake the project under this rule? In order to implement the payback rule, we need to know whether the sum of the inflows from the project will exceed the initial investment before the end of 2 years. The project has inflows of $28 million per year and an initial investment of $81.6 million.

The project will be rejected.

A printing company prints a brochure for a client and then bills them for this service. At the time the printing company's financial disclosure statements are prepared, the client has not yet paid the bill for this service. How will this transaction be recorded?

The sale will be added to Net Income on the income statement but deducted from Net Income on the statement of cash flows.

What is the difference between a public and private corporation?

The shares of a public corporation are traded on an exchange (or "over the counter" in an electronic trading system) while the shares of a private corporation are not traded on a public exchange.

What four financial statements can be found in a firm's 10-K filing? What checks are there on the accuracy of these statements? Every public company is required to produce quarterly and annual financial statements. Those statements are:

The statement of financial position. The income statement. The statement of cash flows. The statement of stockholders' equity.

Marginal Corporate Tax Rate

The tax rate a firm will pay on an incremental dollar of pre-tax income

Effective Annual rate

The total amount of interest that will be earned at the end of one year

The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. At what dollar value should the NPV profile cross the vertical axis?

The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity. (Since the $220,000 cash flows are perpetual, the sum of the cash flows (discount rate = 0%) is infinite)

What are the main advantages of organizing a firm as a C corporation?

There is no limit on the number of owners a C corporation may have, thus allowing the corporation to raise substantial amounts of capital. The life of the business can continue beyond the death of any of the owners. The liability of the owners is limited to the amount of their investment in the firm.

Why is it difficult to determine the market price of a private corporation's shares at any point in time?

There is no organized market for its shares.

Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile? A) They do not show how the firm's earnings are expected to change as the result of a particular decision. B) They are not easily predicted from historical financial statements of a firm and its competitors. C) These earnings are not actual cash flows. D) They do not tell how the decision affects the firm's reported profits from an accounting perspective.

They do not tell how the decision affects the firm's reported profits from an accounting perspective.

Consider the following potential events that might have occurred to Global on December 30, 2016. For each one, indicate which line items in Global's balance sheet would be affected and by how much. Also indicate the change to Global's book value of equity. A key competitor announces a radical new pricing policy that will drastically undercut Global's prices.

This event would not affect the balance sheet.

Consider the following potential events that might have occurred to Global on December 30, 2016. For each one, indicate which line items in Global's balance sheet would be affected and by how much. Also indicate the change to Global's book value of equity. Global's engineers discover a new manufacturing process that will cut the cost of its flagship product by more than 50 %.

This event would not affect the balance sheet.

Your firm is purchasing a new telephone system that will last for four years. You can purchase the system for an upfront cost of $150,000, or you can lease the system from the manufacturer for $4,000 paid at the end of each month. The lease price is offered for a 48-month lease with no early termination—you cannot end the lease early. Your firm can borrow at an interest rate of 6% APR with monthly compounding. Should you purchase the system outright or pay $4,000 per month?

Thus paying $4,000 per month for 48 months is equivalent to paying a present value of $170,321.27 today. This cost is $170,321.27 - $150,000 = $20,321.27 higher than the cost of purchasing the system, so it is better to pay $150,000 for the system rather than lease it.

Your firm is purchasing a new telephone system that will last for five years. You can purchase the system for an upfront cost of $300,000, or you can lease the system from the manufacturer for $6,000 paid at the end of each month. The lease price is offered for a 60-month lease with no early termination—you cannot end the lease early. Your firm can borrow at an interest rate of 7% APR with monthly compounding. Should you purchase the system outright or pay $6,000 per month?

Thus paying $6,000 per month for 60 months is equivalent to paying a present value of $303,014.85 today. This cost is $303,014.85 - $300,000 = $3,014.85 higher than the cost of purchasing the system, so it is better to pay $300,000 for the system rather than lease it.

Your firm is purchasing a new fleet of trucks that will last for six years. You can purchase the system for an upfront cost of $500,000, or you can lease the system from the manufacturer for $8,000 paid at the end of each month. The lease price is offered for a 72-month lease with no early termination—you cannot end the lease early. Your firm can borrow at an interest rate of 6% APR with monthly compounding. Should you purchase the system outright or pay $8,000 per month?

Thus paying $8,000 per month for 72 months is equivalent to paying a present value of $482,716.11 today. This cost is $500,000 - $482,716.11 = $17,283.89 lower than the cost of purchasing the fleet, so it is better to lease the fleet for $8,000 per month than to pay $500,000 for it.

Which of the following is NOT a valid method of modifying cash flows to produce a MIRR? A) Discount all of the negative cash flows to the present and compound all of the positive cash flows to the end of the project. B) Discount all of the negative cash flows to time 0 and leave the positive cash flows alone. C) Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the project's lifetime. D) Leave the initial cash flow alone and compound all of the remaining cash flows to the final period of the project.

Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the project's lifetime.

Which of the following statements is INCORRECT based on the time value of money? A) We refer to (1 - rf) as the interest rate factor for risk-free cash flows. B) For most financial decisions, costs and benefits occur at different points in time. C) In general, money today is worth more than money in one year. D) We define the risk-free interest rate (rf) for a given period as the interest rate at which money can be borrowed or lent without risk over that period.

We refer to (1 - rf) as the interest rate factor for risk-free cash flows.

Liquidation or Salvage Value

When an asset is liquidated, any capital gain is taxed as income

Logic of the decision rule

When making an investment decision, take the alternative with the highest NPV, which is equivalent to receiving its NPV in cash today

A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years. The winner calculates the internal rate of return (IRR) of taking the money at the end of each year and, estimating that the discount rate across this period will be 4%, decides to take the money at the end of each year. Was her decision correct?

Yes, because it agrees with the Net Present Value rule (PMT = 600,000, N = 16, I = 4%; calculate PV = $6,991,377, which is greater than $6,000,000)

Peter has a business opportunity that requires him to invest $10,000 today, and receive $12,000 in one year. He can either use $10,000 that he already has for this investment or borrow the money from his bank at an interest rate of 10%. However, the $10,000 he has right now is needed for urgent repairs to his home, repairs that will cost at least $15,000 if he delays them for a year. What is the best alternative for Peter out of the following choices?

Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the business opportunity, which, since it has a NPV > 0 will mean he will still come out ahead after repaying the loan

Which of the following situations is best described by the timeline shown below?

You make payments of $250 per month for six months.

You are thinking about investing $ 5,300 in your friend's landscaping business. Even though you know the investment is risky and you can't be sure, you expect your investment to be worth $ 5,850 next year. You notice that the rate for one-year Treasury bills is 1 %. However, you feel that other investments of equal risk to your friend's landscape business offer an expected return of 12 % for the year. What should you do?

You should invest if the present value of the benefit is greater than the amount you originally invested; in this case you should not invest in the business.

Which of the following firms would be expected to have a high ROE? A) a high-end fashion retailer that has a very high mark-up on all items it sells B) a medical supply company that provides very precise instruments at a high price to large medical establishments such as hospitals C) a grocery store chain that has very high turnover, selling many multiples of its assets per year D) a brokerage firm that has high levels of leverage

a grocery store chain that has very high turnover, selling many multiples of its assets per year

Which of the following firms would be expected to have a high ROE based on that firm's high profitability? A) a brokerage firm that has high levels of leverage B) a medical supply company that provides very precise instruments at a high price to large medical establishments such as hospitals C) a grocery store chain that has very high turnover, selling many multiples of its assets per year D) a low-end retailer that has a low mark-up on all items it sells

a medical supply company that provides very precise instruments at a high price to large medical establishments such as hospitals

Floor Broker

a person at the NYSE with a trading license who represents orders on the floor, balancing speed and price to get the best execution

Straight Voting

a procedure in which a shareholder may cast all votes for each member of the board of directors

Cumulative Voting

a procedure in which a shareholder may cast all votes for one member of the board of directors

Limit Order

a request to buy or sell a stock at a specified price

Market Order

a request to buy or sell a stock at the current market value

What is a firm's net income?

all of the above

You have just taken out a $ 31 comma 000 car loan with a 9 % APR, compounded monthly. The loan is for five years. When you make your first payment in one month, a. how much of the payment will go toward the principal of the loan and b. how much will go toward interest?

a. $232.50 b. $411.01

You have just taken out a $ 24 comma 000 car loan with a 8 % APR, compounded monthly. The loan is for five years. When you make your first payment in one month, a. how much of the payment will go toward the principal of the loan and b. how much will go toward interest?

a. $326.64 b. $159.98

Suppose your bank account pays interest monthly with an effective annual rate of 5%. What amount of interest will you earn each month? If you have no money in the bank today, how much will you need to save at the end of each month to accumulate $150,000 in 20 years?

a. (1.05)1/12 - 1 = 0.4074% b. $369.64

Suppose your bank account pays interest monthly with an effective annual rate of 6%. What amount of interest will you earn each month? If you have no money in the bank today, how much will you need to save at the end of each month to accumulate $100,000 in 10 years?

a. (1.06)1/12 - 1 = 0.4868% b. $615.47

You have found three investment choices for a one-year deposit: a. 13 % APR compounded monthly b.13 % APR compounded annually c.11 % APR compounded daily Compute the EAR for each investment choice.

a. 13.803% b. 13.000% c. 11.626%

Your bank is offering you an account that will pay 16 % interest (an effective two-year rate) in total for a two-year deposit. Determine the equivalent discount rate for the following periods: a. Six months b. One year c. One month

a. 3.78% b. 7.70% c. 0.620%

Your bank is offering you an account that will pay 22 % interest in total for a two-year deposit. Determine the equivalent discount rate for a period length of: a. Six months b. One year c. One month

a. 5.10 % b. 10.45% c. 0.8320%

You have found three investment choices for a one-year deposit: a. 9.4 % APR compounded monthly, b. 9.4 % APR compounded annually, and c. 8.7 % APR compounded daily Compute the EAR for each investment choice.

a. 9.816% b. 9.400% c. 9.089%

You own a small piece of commercial land near a university. You are considering what to do with it. You have been approached recently with an offer to buy it for $300,000. You are also considering three alternative uses of the land for yourself: a bar, a coffee shop, and an apparel store. You assume that you would operate your choice indefinitely, eventually leaving the business to your children. You have collected the following information about the uses. What should you do? Initial Cash flow Growth Capital Bar $425,000 $65,000 5.0% 12.0% Coffee $250,000 $45,000 5.5% 12.5% Apparel $700,000 $90,000 4.5% 13.0%

bar should be chosen

You own a small piece of commercial land near a university. You are considering what to do with it. You have been approached recently with an offer to buy it for $600,000. You are also considering three alternative uses of the land for yourself: a laundromat, a bakery, and a bike shop. You assume that you would operate your choice indefinitely, eventually leaving the business to your children. You have collected the following information about the uses. What should you do? Initial Cash flow Growth Capital Laundry $200,000 $35,000 2.0% 7.0% Bakery $750,000 $45,000 3.5% 6.5% Bike $800,000 $40,000 4.5% 7.0%

bike shop should be chosen

Consider the above statement of cash flows. What were AOS Industries' major means of raising money in 2008?

by issuing debt

A factory owner wants his workers to produce as many widgets as they can so he pays his workers based on how many widgets they produce. However, in order to make sure that the workers do not rush and produce a large number of poorly made widgets, he checks the widgets at random at various stages of their manufacture. If a defect is found in a widget, the pay of the entire section of the factory responsible for that defect is docked. How is this factory owner seeking to solve the agency conflict problem in this case?

by supplying incentives so the agents act in the way principal desires

A corporate raider gains a controlling fraction of the shares of a poorly managed company and replaces the board of directors. How does the corporate raider hope to make a profit in this case?

by the rise in the value of the stock held by the raider when the new board of directors is judged to be superior to the ousted board of directors

Which of the following best defines incremental earnings? A) the net present value (NPV) of earnings that a firm is expected to receive as the result of an investment decision B) the earnings arising from all projects that a company plans to undertake in a fixed time span C) cash flows arising from a particular investment decision D) the amount by which a firm's earnings are expected to change as a result of an investment decision

cash flows arising from a particular investment decision

You own a small piece of commercial land near a university. You are considering what to do with it. You have been approached recently with an offer to buy it for $220,000. You are also considering three alternative uses yourself: a bar, a coffee shop, and an apparel store. You assume that you would operate your choice indefinitely, eventually leaving the business to your children. You have collected the following information about the uses. What should you do? Initial Cash flow Growth Capital Bar $400,000 $60,000 3.5% 12% Coffee $200,000 $40,000 3% 10% Apparel $500,000 $75,000 3% 13%

coffee shop should be chosen

The Payback Rule

if a project's calculated payback period is less than the pre-specified period of time then the project should be accepted

The after-tax cost of debt ________ the before-tax cost of debt for a firm that has a positive marginal tax rate.

is always less than

The ultimate goal of the capital budgeting process is to ________.

list the projects and investments that a company plans to undertake in the future

A sole proprietorship is owned by ________.

one person

Jim owns a farm that he wants to sell. He learns that a highway will be built near the farm in the future, giving access to the farmland from a nearby city and thus making the land attractive to housing developers. Expecting the net present value (NPV) of the sale to be greater after the highway is built, he decides not to sell at this time. What real option is Jim taking?

option to delay

A manufacturer of peripheral devices for PCs decides to try and capture some of the PC gaming market by creating gaming versions of its traditional peripheral devices. It decides to start with a gaming version of its standard keyboard, increasing the number of macro keys, adding a small LCD screen to display game data, and giving the user the ability to backlight keys in different colors. If this device is a success, the manufacturer plans to release gaming versions of its trackballs and other peripherals. What option is the manufacturer gaining by the release of the new keyboard?

option to expand

Which of the following decision rules might best be used as a supplement to net present value (NPV) by a firm that favors liquidity? A) payback period B) profitability index C) MIRR D) equivalent annual annuity

payback period

Most corporations measure the value of a project in terms of which of the following?

present value

Which of the following is NOT a role of financial institutions? A) printing money for borrowers B) moving funds though time C) spreading out risk-bearing D) moving funds from savers to borrowers

printing money for borrowers

You are opening up a brand new retail strip mall. You presently have more potential retail outlets wanting to locate in your mall than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space?

profitability index

The Weighted Average Cost of Capital: Unlevered Firm

rWACC = Equity Cost of Capital

A delivery company is creating a balance sheet. Which of the following would most likely be considered a short-term liability on this balance sheet?

revenue received for the delivery of items that have not yet been delivered

An exploration of the effect of changing multiple project parameters on net present value (NPV) is called ________.

scenario analysis

An analysis that breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as one of the underlying assumptions changes is called ________.

sensitivity analysis

Which of the following types of firms does NOT have limited liability? A) limited partnerships B) corporations C) sole proprietorships D) none of the above

sole proprietorships

Which of the following is NOT a financial statement that every public company is required to produce? A) balance sheet B) income statement C) statement of sources and uses of cash D) statement of stockholders' equity

statement of sources and uses of cash

Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings? A) subtracting depreciation expenses from taxable earnings B) adding all non-cash expenses C) adding depreciation D) subtracting increases in Net Working Capital

subtracting depreciation expenses from taxable earnings

An insurance office owns a large building downtown. The sixth floor of this building currently houses its entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be rented and for what price, the company must decide whether to split the Human Resources Department between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as they currently are. Which of the following should NOT be considered when deciding whether to rent out the sixth floor? A) the amount obtained by renting the sixth floor B) cost involved with a loss of efficiency resulting from the Human Resources Department being split between several spaces C) the cost of the research into the feasibility of renting the sixth floor D) the cost of refurbishing the new space to be occupied by the Human Resources Department

the cost of the research into the feasibility of renting the sixth floor

Which of the following would you NOT consider when making a capital budgeting decision? A) the opportunity to lease out a warehouse instead of using it to house a new production line B) the additional taxes a firm would have to pay in the next year C) the change in direct labor expense due to the purchase of a new machine D) the cost of a marketing study completed last year

the opportunity to lease out a warehouse instead of using it to house a new production line

Assume a company requires all projects to have a payback period of three years or less. For the project below, would the firm undertake the project under this rule? Year Expected Net Cash Flow 0 -$10,000 1 $1,000 2 $1,000 3 $12,000

the project will be accepted

the project will not be accepted

Which of the following is NOT an advantage of a sole proprietorship? A) single taxation B) ease of setup C) no separation of ownership and control D) unlimited liability

unlimited liability

You are about to sign the contract for Server A from Table 8.2 when a third vendor approaches you with another option that lasts for 4 years. The cash flows for Server C are given below. Should you choose the new option or stick with Server A?

we should choose Server A

You are considering a maintenance contract from two vendors. Vendor Y charges $100,000 upfront and then $12,000 per year for the three-year life of the contract. Vendor Z charges $75,000 upfront and then $35,000 per year for the two-year life of the contract. Compute the NPV and EAA for each vendor assuming an 8% cost of capital.

we should choose Vendor Y

Holding everything else constant, an increase in cash ________ a firm's net debt.

will decrease

Suppose Capital One is advertising a 60-month, 5.03 % APR motorcycle loan. If you need to borrow $ 8 comma 800 to purchase your dream Harley-Davidson, what will be your monthly payment?

$166.19

You have just sold your house for $ 1,050,000 in cash. Your mortgage was originally a 30-year mortgage with monthly payments and an initial balance of $ 850,000. The mortgage is currently exactly 18.50 years old, and you have just made a payment. If the interest rate on the mortgage is 6.50 % (APR), how much cash will you have from the sale once you pay off the mortgage?

$528,781

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